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IT SERVICES

Analysis of Computer Science Corp. Third Quarter FY04 Business Results

Good Quarter Gets Boos

Strong New Contract Sales, Weak U.S. Commercial Revenues

PHOENIX, February 13 – Computer Science Corp.’s (CSC) executives should empathize with Rodney Dangerfield.  Wall Street showed no respect for CSC following the release of its third quarter of fiscal year 2004 results (Feb 11).  CSC shares dropped by more than 8% on Thursday and Friday despite a good quarterly report.  Adding insult to injury, the humiliation happened the day the Dow and most of CSC competitors’ shares thrived.

The reason?  Who knows...  CSC’s latest earnings basically met analyst expectations, while the revenues surged by 30%, boosted by last year’s DynCorp acquisition and by foreign currency translations. 

The best news, however, was the new contract sales.  They more than tripled in the latest quarter, from $1.8 billion a year ago, to $6.0 billion.  That’s a new all-time record for a single quarter.

[snip]

Slowing Commercial Revenues

If there was a fly in CSC’s third quarter ointment, it was the U.S. commercial revenues.  While the U.S. government business has been booming (up 30% in the quarter), the U.S. commercial revenues were down 5%.  As a result, CSC’s global commercial revenues also declined 1% in constant currency (they were up 8% as reported).

[snip]

No. 10 “Death Merchant”

In short, CSC has done a complete turn-about-face since 9/11.The company is now the 10^th-largest Pentagon supplier, a big jump from the No. 21 position before the DynCorp acquisition.

Besides CSC (#10), EDS (#27), Dell (#35) and IBM (#50) are among the Top 50 U.S. “death merchants,” based on the Pentagon spending report for 2003 (see the Pentagon Top 50 table)

Just in case you may be wondering if the 213% increase in CSC’s revenues from the Pentagon tops the top 50 list, it doesn’t.  That dubious honor goes to vice president Dick Cheney’s former company – Halliburton.  Despite the controversy over its over-charging the Pentagon for some of its oil deliveries in Iraq, this company recorded a whopping 711% jump in 2003 revenues. 

[snip]

The “Not-So-Free” Cash Flow

Meanwhile, back to CSC’s latest quarter, free cash flow, or lack thereof, is a legitimate reason for Wall Street’s worrying about the financial performance.  During the first nine months of the current fiscal year, the free cash flow was a negative $173 million, more than double the corresponding amount a year ago ($85 million).  As a result, CSC’s cash on hand dropped by over 50%, from $300 million as of March 28, 2003, to $148 million as of Jan 2, 2004.

[snip]

Summary and Outlook

On balance, there seem to be at least as many reasons to cheer the latest CSC report card, as there are to pan them.  Surging sales are bound to translate into growing revenues and profits in the future.  Yet Wall Street has chosen to ignore the good and boo the bad.

As a result, CSC’s devalued stock price, even if it is still within 10% of its 52-week high, appears a relative bargain compared to its major rivals (see the table).

That’s especially evident in terms of the Price/Earnings Growth (PEG) ratio, a forward-looking statistics measuring a stock’s valuation against its projected growth rate (calculated as a P/E Ratio divided by the 5-year expected growth rate).

The PEG Ratio makes the CSC stock look like the best bargain, followed by Accenture, IBM and EDS, in that order.  So anyone still booing CSC may be missing a good play in a global wartime economy.

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